July 25, 2011

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The proposals and counter-proposals and counter-counter-proposals on how to pass a debt ceiling hike have been flying at a furious pace in Washington. Most people left their offices in the capital on Friday contemplating a “grand bargain” between President Obama and House Speaker John Boehner, in which there would be about $3 trillion in cuts, serious reductions in Social Security, Medicare and Medicaid benefits, and $800 billion in new revenues—generated by a tax code overhaul that would have lowered overall rates but closed a wide variety of personal and corporate loopholes and exemptions.

But before Friday’s happy hours were even over, the deal was dead. An angry President Obama appeared from the White House podium just after 6 pm, blasting Boehner for pulling out of the deal that Obama described as “unbalanced in the direction of not enough revenue.” Boehner appeared at a Hill press conference not long after, blaming Obama for insisting on an additional $400 billion in revenue.

Negotiations are now being conducted between Congressional leaders. Republicans are crafting plans to enact a short-term debt ceiling hike, with commensurate cuts and no revenue, while the White House and Congressional Democrats insist any short-term hike is unacceptable and won’t pass the Senate nor be signed by the president. Instead, Senate Majority Leader Harry Reid is reportedly crafting a package that cuts $2.7 trillion in spending, with no revenue increases, and raises the debt ceiling until 2013.

Though it’s hard to rule out any possibilities as Boehner and Reid crank the debt ceiling Rubik’s cube, one thing seems clear: revenues are permanently off the table. Since Reid has released a revenue-less proposal with one week and a day until the country defaults, it’s hard to see how revenue is revived for any deal.

Removing revenue from the deal seems like (yet another) stunning capitulation by Democrats. For months, both the White House and Congressional Democrats havebeeninsisting that new revenue must be part of any deal. As recently as Thursday, Reid himself said “there has to be some revenue in the cuts, my caucus agrees with that, and hope the president sticks with that.”

In this sense, the Republicans have won. Their original position all along was to cut spending without revenue increases, it now seems they will succeed in making Grover Norquist happy. And in a larger sense, forcing a Democratic president and a Democratic Senate to cut trillions of dollars in spending amidst a recession is a substantial political feat.

But there are some important ways in which the Republicans’ hard line on taxes may have been self-defeating in the long run, and why Reid’s new proposal isn’t so bad given the alternatives.

For one thing, entitlement cuts seem to also be off the table, and that would have been a disaster at both the political and policy levels. (Paul Krugman has a terrific evisceration of the proposed entitlement cuts today.)

More important to note is that the new revenue in the grand bargain would have essentially replaced an expiration of the Bush tax cuts. Under the grand bargain, a tax code overhaul—which, again, lowered rates while eliminating exemptions—would have done away with the old tax system and replaced it with a new one, and the Bush tax cuts become a non-issue.

The expiration of the Bush tax cuts would generate far more revenue for the government than the $800 billion in the original grand bargain—and would also raise rates on top earners instead of lowering them.

Obama already pledged a fight on letting the Bush tax cuts expire—he was actually slyly reneging on that pledge with the tax overhaul proposed in the grand bargain, but with its death comes an opportunity for Democrats to fight another day on a more fair tax system that generates more revenue.

It’s extremely unlikely that Boehner didn’t realize this. But reports suggest he just can’t get his hard-line members to agree on any revenue generation now. Too bad for them—and not so bad for Democrats.